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Suzlon: Research meet extracts

Nov 20, 2008

We recently met up with the management of Suzlon Energy to discuss the current business environment, the companyís performance therein and how is it trying to cope up with the rapid changes happening across the industry. Here are the extracts of the meeting.
On credit crisis affecting project execution: According to the management, the effects of the current liquidity crunch have not affected execution of current projects in any significant way. That is because most wind turbine generator (WTG) orders are for big projects consisting of installation of large wind farms. Thus the financial closure from the customerís side of such orders is done much in advance (usually 2 years) and hence the projects currently being executed are not facing any major liquidity issues. Also internationally, Suzlonís customers are mostly utilities which tend to be cash rich. So that is another aspect that is aiding smooth execution pf current orders.

Revenue visibility: Suzlon already has orders to be executed till FY10, thus visibility is strong until then. Beyond that, as per the management, revenues will depend on new order inflows from here onwards. The current order inflows are relatively slower than a year ago. But on the other hand many countries have laid down strict guidelines for utilities in terms of the minimum percentage of electricity they need to generate from renewable sources. So that would act as another demand driver going forward.

Capex: Suzlon has already incurred capital expenditure of Rs 12 bn in 1HFY09 and has plans for a further Rs 9.7 bn for the rest of this financial year. It has received sanctioning for a Rs 12 bn loan as also an infusion of Rs 4 bn from IDFC for its subsidiary SE Forge. The management has conveyed that it plans to slow down on capex from FY10 onwards and would then focus its efforts on increasing profitability.

On profitability: Suzlonís margins during the 1HFY09 were not up to the mark mainly due to a spike in raw material costs, increase in staff size, as also a spike in logistics costs due to high oil prices and high freight rates. According to the management, with the prices of oil and other commodities now cooling off, margins are expected to be better during the rest of the year. We have however lowered our estimates of FY09 operating margins to 11.3%, from 14.6% earlier.

On blade cracks: The company has faced certain issues with regards to the V2 blades on its S88 turbines installed in the US and Portugal. It has undertaken a retrofit program for the same, wherein it would replace the blades that have developed cracks and strengthen the rest that would prevent them from developing any cracks in future. The company has provided US$ 30 bn for the cost of the entire retrofit program in FY08 itself. The program is currently in progress and the extraordinary expenses incurred during the current year are for compensating the customers for the loss of electricity that could be generated by the turbines being worked on. The management has expressed that it would stand to lose its reputation due to this problem only if does not satisfactorily address the customerís concerns.

On REpower: Suzlon would now complete the acquisition of Martiferís 22% stake in REpower by May 2009. The company would then have close to 90% stake in REpower and would go in for the domination agreement which would give it full access to the latter.

Conclusion
At the current price of Rs 46, the stock is trading a multiple of 9 times our FY09 estimated earnings (excluding extraordinary expenses). While this seems attractive given the valuations the stock has traded at in the past, the fact that visibility regarding Suzlonís future performance has diminished significantly, we would advise investors to practice caution. Given the fact that the liquidity crunch will slow down new order intake for the company, the growth is expected to remain muted over the next 2 to 3 years.

We have lowered our revenue estimates for the company from a compounded annual rate of 28% during FY08 to FY11, to 18%. The major hit is expected to come on the profitability front, as operating margins are expected to remain in a band of 11% to 13% over the next 2-3 years.

Suzlon has recorded large (though notional) extraordinary expenses during 2QFY09, which will also hit its net profits for the full year. These losses have largely been on the back of forex losses on international borrowings recorded by the company, mark-to-market losses, and cracked wind turbine restoration costs which were incurred as part of the retrofit program which the company has undertaken to rectify the blade crack problems faced by its turbines in the US. While the company has recorded a net loss of Rs 2.1 bn during 1HFY09, we expect the full year profits to be a miniscule Rs 1.9 bn. However, this is assuming that the rupee remains stable during 2HFY09 and the company has no incremental extraordinary losses to bear during this period.

Based on these extraordinary items as also the pressure on profitability, our estimates for Suzlonís compounded annual growth in earnings for the period FY08 to FY11 now stands at 12% (excluding extraordinary items).

Overall, we maintain our negative outlook on Suzlon despite the stockís valuation being attractive. The aggressiveness to grow that Suzlon has shown over the past few years is commendable. However the fact that it has sacrificed margins and return ratios to achieve such a growth remains our formidable concern with respect to the company.

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